The following item is a Letter of Intent of the government of Nicaragua,
which describes the policies that Nicaragua intends to implement in the context
of its request for financial support from the IMF. The document, which is the
property of Nicaragua, is being made available on the IMF website by agreement
with the member as a service to users of the IMF
website.

1. Attached is a memorandum on the economic and financial policies of Nicaragua, setting
forth the objectives and policies that the government intends to pursue for the three-year
period 1998-2000, and the objectives and policies for the first annual program there-under.
The Government of Nicaragua believes that the policies set forth in the memorandum are
adequate to achieve these objectives and will take any further measures that may become
appropriate for this purpose. In support of these objectives and policies, Nicaragua hereby
requests a three-year arrangement under the Enhanced Structural Adjustment Facility in a
total amount equivalent to SDR 100.9 million (105 percent of the quota), and the first annual
arrangement thereunder in the amount equivalent to SDR 33.6 million (35 percent of the
quota).

2. During the period of the first annual arrangement, the Government of Nicaragua will
consult with the Fund on the adoption of any measures that may be appropriate, at the
initiative of the government or whenever the Managing Director of the Fund requires such
consultation. In addition, the government will conduct with the Fund a midterm review of the
first annual program. In this connection, in the case of fiscal under performance, large
shortfalls in external resources or difficulties in rolling over short-term central bank financial
instruments, the government would take additional measures, including increases in the VAT
rate and in the retention rate on coffee.

3. After the period of the first annual arrangement and while Nicaragua has outstanding
financial obligations to the Fund arising from loans under the arrangement, the government
will consult with the Fund from time to time, at the initiative of the government or whenever
the Managing Director requests consultation on Nicaragua's economic and financial
policies.

4. Nicaragua is committed to provide the Fund with such information as the Fund requests on
the progress made in policy implementation and the achievement of the program
objectives.

Sincerely yours,

/s/
Noel Ramirez SánchezPresidentCentral Bank of Nicaragua

/s/
Esteban Duque EstradaMinister of Finance

Memorandum of Economic and Financial
Policies

I. Introduction

1. By 1990, following a decade of civil war and economic decline, public sector
expansion, and hyperinflation, real GDP in Nicaragua had dropped to two-thirds and export
volume to one-half of the pre-1980 levels, with per capita income falling to the same level as
in the 1920s. The extent of the deterioration was reflected in the country's social indicators
with those on infant and maternal mortality, and birth weight the poorest in the Western
Hemisphere. At the same time, external debt multiplied tenfold to US$11 billion
(700 percent of GDP). Social conditions had severely deteriorated and poverty became
widespread. Consequently, Nicaragua was not only one of the poorest countries in the
Western Hemisphere but also one of the most indebted countries in the world.

2. Subsequently, Nicaragua changed its course drastically, peace was re-established,
democracy restored, and substantial progress in policy implementation was made to reduce
macroeconomic imbalances and to transform to a market-based economy. Financial policies
were strengthened, most price controls were eliminated, and the foreign exchange and trade
system was liberalized. A program of public asset divestment was implemented, and public
employment and military outlays were cut substantially. Private banks were allowed to
operate again and the Superintendency of Banks (SBIF) was created. Substantial progress
was achieved in obtaining debt relief from external creditors. Nevertheless, macroeconomic
conditions remained fragile and the structural reform process virtually stalled in mid-1996.
Despite important progress in social conditions, poverty remained widespread.

3. In early 1997, a new administration took office. The change of administration provided
an opportunity for Nicaragua to retake the path toward macroeconomic stabilization and
structural reform to achieve sustainable economic growth and improve social conditions. In
this context, the government has prepared a medium-term economic and structural reform
program, covering the 1997-2000 period, which is detailed below. In support of this program
the government is requesting a new three-year ESAF arrangement from the International
Monetary Fund and the corresponding annual arrangements thereunder.

II. Economic Background

4. Nicaragua's economic condition has improved substantially since 1994. After more
than a decade of decline, real GDP grew by 3.3 percent in 1994 and by
4.5 percent in 1996. Domestic investment and private capital inflows have increased
noticeably, and unemployment-which had risen since the late 1980s-started to decline in
1994. The 12-month rate of inflation fell from 20 percent at end-1993 to
12 percent at end-1996. During the first ten months of 1997, economic activity
continued to expand at a strong pace while the 12-month rate of inflation declined to
9 percent.

5. The public finances deteriorated significantly during 1996, reflecting large expenditure
overruns in the period leading up to the presidential elections, and a weak performance of the
public enterprises (mainly of the power company (EEL) and the water company (IAA)) and
the social security institute (INES). Thus public sector savings (including the losses of the
central bank (BAN)) fell to 1½ percent of GDP and the combined public sector
deficit (before grants) reached 15½ percent of GDP. Compared to 1996, the
fiscal position improved in the first nine months of 1997 reflecting, in part, increased tax
collections. However, with a large shortfall in net external financing, BAN net credit to the
public sector was equivalent to almost 7 percent of the year's GDP (compared with net
credit to the public sector of over 3 percent of GDP in 1996).

6. Control over credit policy weakened in 1996 because of the deterioration of the public
finances and the financial difficulties of the state-owned banks associated with problem loan
recoveries. While currency grew in line with nominal GDP, the rate of growth of broad
money accelerated markedly associated with an increase in foreign currency deposits, and
demand and time deposits; at the same time, the growth of bank credit to the private sector
also accelerated. In the face of pressures on the net official international reserves (NGR), the
BAN began selling exchange rate indexed instruments (CANIS) at interest rates of up to
25 percent (declining to 11 percent by mid-1997). Despite the placement of
CANIS equivalent to US$340 million (18 percent of GDP), at end-November 1997 the
stock of NGR stood at US$159 million. Gross reserves were about equivalent to the
outstanding amount of CANIS.

7. In 1995-96 Nicaragua reached restructuring and debt-reduction agreements with its
official and private bilateral creditors that reduced its debt to US$6 billion at end-1996
(300 percent of GDP). Moreover, an agreement was reached in September 1997 on the
restructuring of the US$560 million of outstanding debt (including all arrears) with the
Central American Bank for Economic Integration (CABER) which eases considerably the
cash-flow burden on Nicaragua. Total scheduled external debt-service obligations are
projected at the equivalent of 40 percent of exports of goods and services in 1997,
compared with 92 percent in 1996 and an average of 309 percent in
1993-94.

8. During 1994-96 progress was made on structural reforms, although advances in some
areas were slower than expected. In November 1995, the National Assembly approved
legislation for the privatization of the telephone company (ANETHOLE). However,
following an unsuccessful international bidding process, a new process of privatization has
been undertaken which contemplates the sale of the company by mid-1998. To this effect
updated and improved legislation has been sent to the National Assembly for its
consideration. Regarding property rights, progress has been made in the process of delivering
urban and rural property titles to the poor, the continuing return of state-owned properties,
and the compensation of claimants. Interest on compensation bonds (issued to compensate
owners of confiscated property) is being paid on time. Reflecting a political consensus, a new
law ("Ley de la Propiedad Reformada Urbana y Agraria") was approved in
November 1997 by the National Assembly, that will allow the resolution of pending claims
and speed up the delivery of property titles. This law should allow the settlement of a large
number of small property claims and it also creates special property courts to address pending
cases. The government plans to deliver 90,000 property titles to small urban and rural plot
holders in the next two years.

III. The Economic Program for 1997-2000

9. The main objective of the government's economic program for 1997-2000 is to fight
poverty and reduce unemployment. The program includes measures that aim at restoring the
sustainability of the government and external finances, and at implementing needed structural
reforms to achieve sustained high rates of economic growth. The government will focus its
efforts in developing the rural sector and will redirect public investment toward the rural
areas. Under the program real GDP is projected to grow by 5 percent a year
(2 percent in per-capita terms) on the basis of increased private sector investment and
the strength of agricultural and nontraditional exports. At the same time, inflation would
decline to 8 percent in 1998 and 5 percent by 2000. The financial program
targets an increase in NGR by a cumulative US$155 million during 1997-98; furthermore
gross reserves (net of the stock of outstanding CANIS) would increase from 1.7 months of
imports by end-1998 to around three months of imports by end-2000. The authorities expect
to be considered for eligibility under the HIPC initiative by-end 1999 on the basis of the
significant domestic effort being undertaken and the successful implementation of the
program.

10. Achievement of the program's high rates of economic growth will require a
significant effort to implement structural reforms that increase efficiency and foster private
investment. Following the successful introduction of a tax reform in May 1997, the
government is strengthening tax and customs administration. Government expenditure will
be rationalized and the size of the state reduced. The foreign investment code will be revised
to eliminate any bias against investors and the privatization process will be sequenced
appropriately, starting in sectors with a high likelihood of success (telecommunication and
energy sectors). The process of state banking reform has been initiated; the Development
National Bank (BANADES) will cease banking functions and alternative financial
institutions for small producers, without direct participation of the government, will be
established. Particular attention will be paid to decentralizing and increasing social spending
(for education and health), and settling property rights to ensure civil peace and economic
prosperity.

11. The fiscal program aims at putting the public finances on a sustainable path given the
projected external financing and the likelihood of external debt relief under the HIPC
initiative. The combined public sector deficit (before grants) would decline from
15½ percent of GDP in 1996 to under 4 percent of GDP by 2000. Public
savings are expected to rise significantly during the three-year ESAF arrangement, with an
important part of the adjustment coming in the first year (an increase of
1½ percentage points of GDP in 1998 and an additional increase of
4 percentage points of GDP by 2000). Public sector investment (in terms of GDP) is
projected to decline markedly in the 1997-2000 period but, this is expected to be offset by a
rise in private sector investment reflecting both planned privatization of public utility
companies and strengthening in confidence.

12. The program includes a number of actions to raise central government revenue by a
total of 2½ percentage points of GDP through 2000, with all of the increase
coming in 1997-98. The government is committed to improve the transparency of the public
sector operations by broadening the budget coverage to include revenue and expenditure
operations not previously reported. In this connection, the fiscal accounts include
1 percentage point of GDP of current revenue that previously was part of extra
budgetary revenues. In May 1997 a tax reform was passed that aims at correcting structural
deficiencies of the tax system and expanding the tax base by reducing or eliminating
discretionary and other exemptions to the VAT and customs duties, and introducing a land
tax while reducing import duties to two tiers (5 and 10 percent) by end 1999.
Moreover, in September 1997 the government initiated a process to correct the distortion in
the relative prices of gasoline and diesel, increasing the price of diesel and decreasing that of
gasoline, and took measures to improve the control mechanism of the retention of the coffee
income tax. The government stands ready to take additional measures in case of fiscal under
performance, large shortfall in external resources, or difficulties in rolling over CANIS.

13. Current outlays of the central government are programmed to decline from about
22½ percent of GDP in 1996 to 18½ percent of GDP in 2000
(one-half of this reduction is to take place in 1997-98) reflecting a freeze in these
expenditures (excluding interest payments and transfers mandated by the constitution but
including wages) and a reduction in export subsidies. The government will request technical
assistance from the Fund to establish mechanisms to ensure compliance with this objective.
In an effort to increase the transparency of government operations, the fiscal accounts include
almost 2 percentage points of GDP of expenditure that previously were part of extra
budgetary expenditure. The decline in current outlays will be achieved, in part, through a civil
service reform program consistent with the restructuring of the government. In addition to the
1,800 public sector positions closed during 1997, it is estimated that a further 1,500 positions
a year will be cut during 1998-99. These figures are subject to revision in light of the law for
restructuring the Executive Branch, that has been presented to the National Assembly for
approval.

14. The government will continue to make efforts to shift current expenditures toward
the social sectors, particularly health and education and will emphasize programs that
alleviate poverty. In this effort, social expenditure would be increased (in consultation with
the IMF and IBRD) beyond the amount budgeted, and will be financed through the use of
proceeds from ANETHOLE's privatization and increased contributions by donors through a
support group that will be formed for this purpose and the Consultative Group meeting for
Nicaragua scheduled in April 1998.

15. Capital outlays and net lending of the public sector are programmed to decline by
5 percentage points of GDP in 1997 to 12 percent of GDP and to remain on
average at about that level through 2000. As mentioned, private sector participation in the
provision of infrastructure services formerly reserved to the public sector (energy,
telecommunications, ports, and roads) is expected to increase substantially after the passing
of a set of new laws, by end-1997 (described in Table 6).
The public investment program will give priority to investment in the social sectors and in
basic infrastructure and will aim at greater medium-term sustainability in the services
provided. The institutional capacity for the formulation, evaluation, prioritization, execution,
and follow up of investment projects shall be upgraded, so that the public investment
program reflects the short- and medium-term expenditure capacity of the government, and a
more rational allocation of resources.

16. The strengthening of the financial position of the state enterprises through revenue
increases and cost containment will be an important component of the fiscal program. The
long standing financial problems of EEL have continued to compound as the level of energy
losses have risen and the increasing reliance on thermal generation has raised generation
costs. Beginning in April 1997 EEL raised its monthly rate adjustments from 1 percent
to 1.5 percent. However, this has not been sufficient to compensate for recent cost
increases that have been driven, in part, by drought conditions associated with El
Niño. In this context, EEL instituted a step adjustment of 5 percent effective
October 1, 1997; in addition, the government has approved the introduction of a permanent
thermal factor in the pricing structure of EEL to help offset the increase in costs attendant to
the use of thermal energy during drought situations (low-income consumers have been
exempted from these tariff increases); EEL also will strengthen its collection procedures, and
enforce a tight rein on current outlays. Also, the government has requested assistance from
the IBRD and IDB to support EEL's investment program and financing requirements,
including to compensate for the effect of El Niño on its finances. To protect the
financial situation of IAA from energy cost increases, tariff rates will be increased in line
with the recommendations of a recent study undertaken with technical assistance from the
IDB. During the program period, the electricity and water rates will continue to be adjusted
by 1.5 percent a month.

17. The government intends to carry out a study to develop options for the reform of the
social security system. This study, which will be concluded with the technical assistance from
the IBRD and the IDB, will aim at strengthening the current system while allowing
participation of the private sector in the supply of health services and ensuring actuarial
viability of the pension system. In the meantime, in order to improve the finances of the
social security system, the government intends to revise contribution rates, pensions,
retirement age, and to improve the financial management of the social security institute.

18. The monetary program will be consistent with the inflation and external objectives of
the program and will be based on an increase in currency issue broadly in line with the
growth of nominal GDP. The net domestic assets of the BAN (NDA) are projected to
contract by an amount equivalent to some 2 percent of GDP in 1997 and are
programmed to decline by about 3 percent of GDP on average in 1998-2000. The
contraction of NDA will reflect the planned improvement in the nonfinancial public sector
position with the BAN, and the expected reduction in the BAN losses starting in 1999 (after a
projected marked increase in 1997-98). This reduction reflects lower interest payments
associated with the net redemption of CANIS (beginning in 1998) and higher interest revenue
resulting from increased international reserves.

19. The BAN will conduct a tight credit policy while the fiscal position strengthens. In
this context, directed credit policies (in favor of agriculture) recently were eliminated and will
not be reintroduced. Also, in October 1997, reserve requirements were unified at
17 percent across deposit maturities as well as currency denomination and were
extended to all bank liabilities with the private sector. The BAN increasingly will use open
market operations as the main instrument of monetary control. Along these lines, the
authorities recently have replaced the system of selling an open quantity of CANIS at a
pre-set interest rate with an auction system where the quantity of CANIS offered is
determined on the basis of the need to sterilize excess liquidity in line with the monetary
program, and the interest rate determined in the auction. In this regard, the authorities intend
to reduce the stock of CANIS by at least the equivalent of US$130 million during the
program period.

20. Measures are being undertaken by the government to ensure the soundness of the
banking system. Improvement in the regulatory framework and in its implementation shall be
furthered in order to reduce discretionality, enhance banking competition, and increase bank
solvency through increasing the capital base. In order to consolidate the successful growth
that the private banking sector has shown since 1991, a concept of capital adequacy was
adopted in 1992 based on Basle norms. The capital adequacy ratio was increased from
6 percent to 8 percent in 1996, and the government intends to increase the
capital adequacy ratio further, to 10 percent by 2000. In 1993, the BAN and the SBIF
promoted development bonds (BOFOS) that could be issued by private banks and counted as
secondary capital. Beginning in July 1999, these bonds will no longer serve as secondary
capital. The SBIF will pay particular attention to the strict enforcement of the existing
prudential norms, including restrictions regarding the concentration of banks' assets. Also, the
SBIF role of regulating new lines of banking business such as leasing and mortgage financing
will be reviewed to ensure that any existing discretionality will be eliminated. The
government will support financially the SBIF to ensure the successful implementation of its
duties.

21. Implementation of the financial policies and structural reforms described in this
memorandum will further strengthen Nicaragua's external position. However, because of the
country's still low export base and high debt-service obligations, the external financing
requirements would remain large over the next several years. The government will request a
comprehensive rescheduling of the eligible debt on Naples terms from Paris Club creditors in
early 1998. To advance toward external viability, the government's debt management policy
is to rely solely on securing grants and highly concessional loans to cover its external
financing requirements, while at the same time continuing to actively pursue agreements with
remaining creditors on debt and debt-service reduction on terms at least comparable to those
granted by Paris Club creditors. The public sector commits to refrain from contracting or
guaranteeing any new loans on nonconcessional terms. In order to enhance the effectiveness
of its debt management, the Ministry of Finance will coordinate all external debt functions
with the BAN ensuring on a continual basis that no new external arrears are incurred during
the program period, except for obligations which are subject of ongoing negotiations with
creditors, or which were considered under the program to be potentially eligible for
refinancing or rescheduling, or other debt relief mechanisms.

22. The BAN approved the unification of the exchange system effective January 1, 1996.
The BAN buys or sells any amount of foreign exchange from the financial institutions at an
exchange rate determined by a crawling peg system. While Nicaragua has maintained its
external competitiveness as evidenced by the strong growth of exports and improvement in
the trade balance in the past several years, its external position remains fragile. As
inflationary pressures are expected to continue to fall, as a result of fiscal and monetary
policies in line with the program, the rate of crawl is expected to be gradually reduced.

23. The government is committed to maintaining a trade system free of nontariff
restrictions and to continue the process of reducing import duties and export subsidies. For
the vast majority of import items, the recently approved tax reform law reduced the
maximum tariff to 30 percent as of July 1997. It also establishes a timetable for
further reductions to 20 percent in January 1998, and to 10 percent in July
1999. The export promotion law, which provides income tax rebates and other tax benefits
for some exports in the form of negotiable certificates (CBTs), is being phased out in 1997.
Firms producing for export shall continue having access to imported machinery, equipment,
and intermediate goods without duty.

24. At the end of 1997 the government will introduce a law for restructuring the
Executive Branch which reduces significantly the number of government ministries, and in
addition agencies that report directly to the president. In order to increase the efficiency and
transparency of the public finances, the government will introduce legislation during the first
quarter of 1998, that will permit, the implementation of a new system of financial
administration for the central government ("Sistema de Evaluación Integral
Financiera del Estado," SEIF). It also will develop pilot projects for local SEIF
representative offices. At the same time, the government will strengthen the National System
of Public Investment (SNIP), with the Office of the Presidency empowered to oversee public
investment across ministries to provide greater cohesion to the country's development
strategy.

25. On financial system reform, the government is reducing state participation in the
banking sector while ensuring that financial services remain available to small farmers. The
government is taking steps to cease the banking function of the largest state bank
(BANADES) and to sell to the private sector its controlling interest in Banco Nicaraguense
(BANIC). The IBRD and the IDB will provide support to finance the losses resulting from
the negative net worth of BANADES branches that have been or will be sold. As of October
1997 a total of 22 agencies and branches representing 80 percent of BANADES
deposits had already been sold to private banks. By May 1998 the Banking Superintendency
will withdraw BANADES' license to operate as a financial intermediary. To serve the credit
needs of small poor farmers, the government will establish a small farmers fund that will
operate as a second tier institution relying on commercial bank branches, cooperatives, and
specialized NGOs with the best practices in rural finance to directly reach poor farmers.

26. The government will increase BANIC's capital by issuing shares to the private sector
and in the process diluting its ownership, becoming a minority shareholder by mid-1998. To
address possible legal issues concerning the ownership of the bank, a law will be passed by
March 1998 establishing that the government is responsible for the eventual indemnization of
the previous owners. In addition, the government intends to privatize a second-tier financial
institution (FNI), which provides financing to commercial banks with government-guaranteed
external borrowing.

27. The government plans to privatize public utilities, the state oil distribution company,
and the services of major ports. To establish the relevant legal framework, legislation for the
hydrocarbon, electricity, and water sectors is under discussion in National Assembly and is
expected to be approved by February 1998. The government will coordinate the privatization
process to ensure transparency and efficiency, reform the tariff structure of electricity and
water services to reflect marginal costs, and eliminate cross subsidization; and will initiate
the required reorganization of EEL and IAA. Consistent with the electricity law, EEL will be
vertically separated and its generation and distribution assets will be sold or given in
concession. Required new law to privatize ANETHOLE will be approved by February 1998
and the bidding process finalized by end-1998.

28. The government plans to modernize the commercial code, the bankruptcy law, the
intellectual property law, and to make appropriate revisions to the foreign investment law.
The latter will be done in a way that avoids unnecessary restrictions, discriminatory
treatment, and the granting of tax benefits not contemplated in the general tax regime, while
guaranteeing stability in the tax and regulatory environment to foreign investors. Also, the
Executive Branch is initiating a comprehensive plan for judiciary and legal reforms that aims
at improving legal procedures and enforcing legal contracts and property rights. The
government is supporting the judiciary branch by investing in and setting up court houses and
civic centers in most municipalities of the country, enhancing the governability and the rule
of law in every part of Nicaragua. To this effect, the government has requested technical and
financial assistance from foreign donors.

29. Concerning the social programs for 1997-2000, in collaboration with the IBRD and
IDB, the authorities will continue to improve the efficiency and quality of social spending
and will invest increased resources in sanitation and water treatment and housing for the
lower income families. In addition, the government will reallocate resources to primary
education and health. The authorities will aim to reduce drop-out rates in the school system
by improving the quality of primary education and education infrastructure. In the health
sector, the government will develop a modern health care system, strengthening primary and
preventive health services. The strengthening of the safety net for the protection of the most
vulnerable sectors of the Nicaraguan population will be a key element of the poverty
alleviation strategy. However, the core of the strategy will be employment generation through
economic growth, based on an improved environment to increase private investment.

30. The attached tables (Tables 1-5) specify the following
quantitative and structural performance criteria for mid-1998: (I) ceilings on the central bank
NDA, on the domestic financing of the nonfinancial public sector; and on net disbursements
of nonconcessional external loans; and floors on net international reserves and on savings of
the combined public sector; and (ii) structural benchmarks that include the divesture of the
state banks, the privatization program, closure of government agencies, and employment
reduction (Table 6). There will be indicative limit on the
deficit of the combined public sector for 1998. Prior actions for Board presentation of the
request (most of which already have been taken) include the approval of the 1998 budget
consistent with the program, the implementation of a critical mass of fiscal measures (such as
an increase in public sector revenues by correcting the relative prices of gasoline and diesel
and an improvement in the control mechanism of the retention of the coffee income tax); the
sale of at least 80 percent of the assets of BANADES; substantive measures to
improve the financial position of EEL and IAA; and the setting up of a plan by the
government for the modernization of the state and presentation to the National Assembly of
the required legislation (in agreement with the IDB) to implement such a plan.